Surviving a bear market

August 4, 2009
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, NAIROBI, Kenya, Aug 5 – Volatility is often defined as the tendency for the overall value of an investment to rise and fall unpredictably. There are several approaches investors could adopt to minimise a bear market’s impact on their investments. The important thing is not to panic and invest wisely over the long-term.

There are several investment strategies that traders can adopt to minimise the risk of a bear market. These strategies typically relate to diversification in terms of asset classes. The asset classes available to investors generally include cash, fixed interest, property, equities, and alternative assets. Investors can also invest in these asset classes wisely as they attempt to survive a bear market.

Cash

Even though investment returns from cash are considerably low, they should generally be safe and receive interest on the capital. By allocating at least some of an investment portfolio to cash an investor will have access to funds for short-term needs and reduce the overall volatility of your portfolio. Investors holding cash may also take advantage of any bargains that a bear market offers.

There are several things that investors in cash will have to consider. Most notably are interest rates which tend to fall in bear markets as governments or central banks try to stimulate the economy which in turn affects the interest paid on cash investments.

Fixed Interest

Fixed interest funds are diverse and wide-reaching, providing investors with exposure to government and corporate bonds. Bonds continue to provide a steady source of income for investors in a bear market, even though the market value of the bonds may be in decline. Depending on the economic outlook, bonds can perform similarly to equities. Bonds tend to perform badly with rising interest rates and rampant inflation. Fixed interest investments are less risky than equities. Although they are not as safe as cash, they often provide a steady source of income.

It is important to note that fixed interest do should not be considered in isolation not only because of its diversity but also because of the impact of economic conditions.

Property

Property has become increasingly popular as an investment over the last decade. Part of the attraction of property is that by its physical nature, it is deemed to hold its value better than something tangible, such as equity. Property is often classified as commercial or residential. From a risk perspective, property is seen as sitting somewhere between equities and bonds. The “credit crunch” has since disputed this view.

In a bear market, falling interest rates may make it cheaper to borrow money in order to purchase properties and this can boost property prices. In a recession, if a bear market leads to a recession then property values and rental income may fall. This is particularly likely if interest rates are high and unemployment is rising.

Equities

Most investors associate a bear market with equities. Some equities pay a higher dividend relative to their share price than others. These are known as high yield shares. As interest rates fall, so the yield from equities may become attractive at the expense of fixed interest investments. Some sectors may fare better than theirs in a bear market. For example, electricity companies are likely to always experience demand regardless of a bear market whereas car manufactures will often see a fall in demand and consequently a fall in their share price.

It is important to diversify your investments in different sectors. Money in a single asset class, sector or company leaves a portfolio very exposed and performance is is likely to be volatile.

Alternative Assets 

Alternative investments are those that have a low correlation with the traditional assets classes (cash, fixed interest, property and equities. They may include tangibles such as commodities, precious metals, timber and infrastructure amongst others. To gain from such investments it is important to get an in-depth understanding of their specific features.

Alternative investments have become more accessible recently with the introduction of alternative investment funds. These funds are likely to achieve their exposure to alternative assets through the shares of companies associated with these different asset classes. It may not be possible for a fund to physically hold gold bullion or water for example but they can hold shares in one of them.

The simplest way to reduce volatility in your investment portfolio however, is to diversify its exposure across a variety of asset classes. There are no obvious rules that apply to bear markets. The above named asset classes however offer you options to help your defence against volatility.

(Renaldo D’Souza is the Marketing and PR Coordinator at Winton Investment Services Ltd, an Offshore Investment Advisory Company based in Nairobi)

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